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Capital Market Imperfections and the Sensitivity of Investment to Stock Prices

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  • Ovtchinnikov, Alexei V.
  • McConnell, John J.

Abstract

Prior studies argue that investment by undervalued firms that require external equity is particularly sensitive to stock prices in irrational capital markets. We present a model in which investment can appear to be more sensitive to stock prices when capital markets are rational, but subject to imperfections such as debt overhang, information asymmetries, and financial distress costs. Our empirical tests support the rational (but imperfect) capital markets view. Specifically, investment–stock price sensitivity is related to firm leverage, financial slack, and probability of financial distress, but is not related to proxies for firm undervaluation. Because, in our model, stock prices reflect the net present values (NPVs) of investment opportunities, our results are consistent with rational capital markets improving the allocation of capital by channeling more funds to firms with positive NPV projects.

Suggested Citation

  • Ovtchinnikov, Alexei V. & McConnell, John J., 2009. "Capital Market Imperfections and the Sensitivity of Investment to Stock Prices," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(3), pages 551-578, June.
    • Handle: RePEc:cup:jfinqa:v:44:y:2009:i:03:p:551-578_99
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    Cited by:

    1. Kusnadi, Yuanto & Wei, K.C. John, 2017. "The equity-financing channel, the catering channel, and corporate investment: International evidence," Journal of Corporate Finance, Elsevier, vol. 47(C), pages 236-252.
    2. Smith, Jason, 2014. "Does the market matter for more than investment?," Journal of Empirical Finance, Elsevier, vol. 25(C), pages 52-61.
    3. Andriansyah, Andriansyah, 2017. "The Real Effect of Primary and Secondary Equity Markets on Firm Performance: Evidence from Indonesia," MPRA Paper 116696, University Library of Munich, Germany.
    4. Shushu Liao & Marco Errico, 2023. "Corporate investment and stock market valuation," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 50(3-4), pages 795-819, March.
    5. Park, Kwangho & Yang, Insun & Yang, Taeyong, 2017. "The peer-firm effect on firm’s investment decisions," The North American Journal of Economics and Finance, Elsevier, vol. 40(C), pages 178-199.

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